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I am running an online shop; I keep my inventory at home and do all my own shipping. Last year I read something about how businesses that keep an inventory can only deduct the cost of goods sold. According to what I was reading, I had been handling all my bookkeeping like a service provider, rather than a shop with an inventory. I have never kept track of my inventory; only sales and expenses. I panicked and paid to talk to a tax pro through turbotax.com. To my surprise, she said everything was okay because I qualified for an exemption in Publication 538, page 14. I'm still a little concerned that I might not be doing this correctly. I found a website that says businesses qualifying for that examption can use the cash method of accounting, but still need to deduct the cost of unsold items from their expenses at the end of the year. If this is the case, then how can I get on the right track without losing a ton of money?

Submitted: 32 days and 22 hours ago.

Category: Tax

Value: $25

Status: CLOSED

Posted by Mark D 32 days and 22 hours ago.

Answer

XXXXXXXX,

Even if you qualify to file under the cash method, you cannot deduct the costs of your inventory on hand. Please see IRS Revenue Procedure 2001-10:

"Qualifying taxpayers that do not want to account for
inventories must treat inventoriable items (i.e., merchandise purchased for
resale and raw materials purchased for use in producing finished goods) in the
same manner as materials and supplies that are not incidental under section
1.162-3."

"Under section 1.162-3, materials and supplies that are not incidental are
deductible only in the year in which they are actually consumed and used in the
taxpayer's business. For purposes of this revenue procedure, inventoriable items
that are treated as materials and supplies that are not incidental are consumed
and used in the year in which the taxpayer sells the merchandise or finished
goods. Thus, under the cash method, the cost of such inventoriable items are
deductible only in that year, or in the year in which the taxpayer actually pays
for the inventoriable items, whichever is later."

The correct action to take would be to amend your prior-year returns to reflect proper inventory accounting. This is the only correct action to take, regardless of the monetary costs of doing so. Please let me know if you have further questions.

Regards,

XXXX X

32 days and 21 hours ago.

Reply

I have never kept track of my inventory. I intend to count everything at the end of this year, but how could I possibly amend my previous returns if I have never kept track of my inventory?

Accepted Answer

XXXXXXXX,

A reasonable estimate should be used. It is better to show an attempt than to do nothing at all.

Regards,

XXXX X

Accepts:
Expert:	Mark D
Pos. Feedback:	99.6 %
Answered:	10/21/2009

Tax Preparer

MBA, CTEC Registered, CPA Firm Experience with Business and Individual Tax Returns and Issues

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